Thursday, September 12, 2013

In his post
Remembering Ronald Coase’s Contributions, Robert Stavins notes a big
surprise, the Wall Street Journal's editorial page being less than forthright (he is summarizing a statement in "an
effective essay" by Severin Borenstein on "the effect that Coase’s thinking
had decades ago on his own intellectual development"):

the Wall Street Journal in its ...
tribute to Coase ... twisted the implications of his work to fit the
Journal’s view of the world

... In our article,
“The Effect of Allowance Allocations on Cap-and-Trade System Performance,”
Hahn and I took as our starting point a well-known result from Coase’s work,
namely, that bilateral negotiation between the generator and the recipient
of an externality will lead to the same efficient outcome regardless of the
initial assignment of property rights, in the absence of transaction costs,
income effects, and third party impacts. This result, or a variation of it,
has come to be known as the
Coase Theorem.

We focused on an idea that is closely related to the Coase theorem, namely,
that the market equilibrium in a cap-and-trade system will be cost-effective
and independent of the initial allocation of tradable rights (typically
referred to as permits or allowances). That is, the overall cost of
achieving a given emission reduction will be minimized, and the final
allocation of permits will be independent of the initial allocation, under
certain conditions (conditional upon the permits being allocated freely,
i.e., not auctioned). We called this the independence property. It is
closely related to a core principle of general equilibrium theory (Arrow
and Debreu 1954), namely, that when markets are complete, outcomes
remain efficient even after lump-sum transfers among agents.

The Practical Political Importance of the Independence Property

...The reason why this property is of such great
relevance to ... public policy is that it allows
equity and efficiency concerns to be separated. In particular, a government
can set an overall cap of pollutant emissions (a pollution reduction goal)
and leave it up to a legislature to construct a constituency in support of
the program by allocating shares of the allowances to various interests,
such as sectors and geographic regions, without affecting either the
environmental performance of the system or its aggregate social costs.
Indeed, this property is a key reason why cap-and-trade systems have been
employed and have evolved as the preferred instrument in a variety of
environmental policy settings.

...Does the Property Always Hold?

...Hahn and I ... carried out an empirical assessment of the independence
property in past and current cap-and-trade systems...

I hope some of may find time to read
our article, but a quick summary of our assessment is that we found
modest support for the independence property in the seven cases we examined
(but also recognized that it would surely be useful to have more empirical
research in this realm).

Political Judgments

That the independence property appears to be broadly validated provides
support for the efficacy of past political judgments regarding constituency
building through legislatures’ allowance allocations in cap-and-trade
systems. Governments have repeatedly set the overall emissions cap and then
left it up to the political process to allocate the available number of
allowances among sources to build support for an initiative without reducing
the system’s environmental performance or driving up its cost.

This success with environmental cap-and-trade systems should be contrasted
with many other public policy proposals for which the normal course of
events is that the political bargaining that is necessary to develop support
reduces the effectiveness of the policy or drives up its overall cost.
So, the independence property of well-designed and implemented cap-and-trade
systems is hardly something to be taken for granted. It is of real
political importance and remarkable social value. It is just one of
many lasting contributions of Ronald Coase.

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'Remembering Ronald Coase’s Contributions'

In his post
Remembering Ronald Coase’s Contributions, Robert Stavins notes a big
surprise, the Wall Street Journal's editorial page being less than forthright (he is summarizing a statement in "an
effective essay" by Severin Borenstein on "the effect that Coase’s thinking
had decades ago on his own intellectual development"):

the Wall Street Journal in its ...
tribute to Coase ... twisted the implications of his work to fit the
Journal’s view of the world

... In our article,
“The Effect of Allowance Allocations on Cap-and-Trade System Performance,”
Hahn and I took as our starting point a well-known result from Coase’s work,
namely, that bilateral negotiation between the generator and the recipient
of an externality will lead to the same efficient outcome regardless of the
initial assignment of property rights, in the absence of transaction costs,
income effects, and third party impacts. This result, or a variation of it,
has come to be known as the
Coase Theorem.

We focused on an idea that is closely related to the Coase theorem, namely,
that the market equilibrium in a cap-and-trade system will be cost-effective
and independent of the initial allocation of tradable rights (typically
referred to as permits or allowances). That is, the overall cost of
achieving a given emission reduction will be minimized, and the final
allocation of permits will be independent of the initial allocation, under
certain conditions (conditional upon the permits being allocated freely,
i.e., not auctioned). We called this the independence property. It is
closely related to a core principle of general equilibrium theory (Arrow
and Debreu 1954), namely, that when markets are complete, outcomes
remain efficient even after lump-sum transfers among agents.

The Practical Political Importance of the Independence Property

...The reason why this property is of such great
relevance to ... public policy is that it allows
equity and efficiency concerns to be separated. In particular, a government
can set an overall cap of pollutant emissions (a pollution reduction goal)
and leave it up to a legislature to construct a constituency in support of
the program by allocating shares of the allowances to various interests,
such as sectors and geographic regions, without affecting either the
environmental performance of the system or its aggregate social costs.
Indeed, this property is a key reason why cap-and-trade systems have been
employed and have evolved as the preferred instrument in a variety of
environmental policy settings.

...Does the Property Always Hold?

...Hahn and I ... carried out an empirical assessment of the independence
property in past and current cap-and-trade systems...

I hope some of may find time to read
our article, but a quick summary of our assessment is that we found
modest support for the independence property in the seven cases we examined
(but also recognized that it would surely be useful to have more empirical
research in this realm).

Political Judgments

That the independence property appears to be broadly validated provides
support for the efficacy of past political judgments regarding constituency
building through legislatures’ allowance allocations in cap-and-trade
systems. Governments have repeatedly set the overall emissions cap and then
left it up to the political process to allocate the available number of
allowances among sources to build support for an initiative without reducing
the system’s environmental performance or driving up its cost.

This success with environmental cap-and-trade systems should be contrasted
with many other public policy proposals for which the normal course of
events is that the political bargaining that is necessary to develop support
reduces the effectiveness of the policy or drives up its overall cost.
So, the independence property of well-designed and implemented cap-and-trade
systems is hardly something to be taken for granted. It is of real
political importance and remarkable social value. It is just one of
many lasting contributions of Ronald Coase.